Funding valuations in 2014 - issues for employers

Employers sponsoring a defined benefit (DB) pension scheme that is carrying out its triennial valuation this year are likely to see upward pressure on the contributions being requested by the trustees. Although on the whole investment returns have been good since the last round of valuations three years ago, gilt yields (often used as a reference point for valuing pension liabilities) remain very low. The combined effect of market changes on assets and liabilities may have led to a larger deficit on the scheme funding basis, despite the recovery in asset values.

The Pensions Bill 2013 gave The Pensions Regulator (TPR) a new statutory objective to 'minimise any adverse impact on the sustainable growth of an employer'. To recognise this, TPR has published its proposed changes to the code of practice on DB scheme funding, effective for valuations completed from July 2014. The new code focuses on an 'integrated risk' approach to funding, as well as striking a balance between the needs of the scheme and reasonable affordability for the employer. This approach addresses covenant, investment and funding risks and also recognises how valuable a healthy sponsoring employer is. The revised approach may enable employers to negotiate lower deficit contributions, if the employer can show that investing the funds elsewhere will lead to a stronger covenant in the long-term.

Furthermore, although the responsibility for setting investment strategy rests with the trustees, TPR recognises that risk should be limited to a level where the employer can mitigate adverse outcomes over a reasonable period. This may lead to investment strategies which better suit the employer.

It is essential that employers take the initiative in managing their scheme and the funding valuation process by getting involved in the valuation process at an early stage, otherwise they risk losing control.

Some potential action points for employers include:

Identify objectives – before entering into discussions with the trustees, employers should understand what they are trying to achieve, for examples whether they wish to keep annual contributions down, or start funding towards a self-sufficient scheme.

Engage with trustees – in many cases trustees are sympathetic to the employer’s circumstances but need the employer to present a clear view on the issues.

Prepare for employer covenant assessment – Having a strong covenant, or being able to demonstrate an improved covenant since the previous valuation will allow the trustees to be more flexible in the assumptions they determine for the valuation.